Debt Forgiveness Act – Short Sales, Foreclosures

Good post from William Tucker about deficiency debts for short sales.

(Debt Forgiveness Act) Most of the federal attempts (HAMP, HAFA, HARP, etc) to deal with the country’s serious real estate problems have been dismal failures.  One of the only winners, however, has been the “Debt Forgiveness Act.”  This act will continue to be effective through December 31, 2012. Normally any “debt forgiveness” is taxable as ordinary income.  Accordingly, if there is a foreclosure and the property is sold at less than the outstanding debt, then this creates a deficiency which usually becomes taxable income.  Likewise, with a short sale, the deficiency created by the short sale is again usually taxable as debt forgiveness.  The lender will usually issue a 1099 for the amount charged off. Under the Debt Forgiveness Act, as long as the property being sold or foreclosed was the residence of the Borrower then the Act applies.  Also the debt being forgiven has to be either purchase money, refinance of the purchase money debt or money borrowed to improve the residence.  Assuming the debt being forgiven meets these conditions, then there will be no taxable income to the Borrower who has just lost or short sold his house. 

PS—Even if the debt being forgiven from a foreclosure or short sale does not qualify as a residence, there are still some exceptions which may result in no taxable income to the Borrower.  Please suggest that the Borrower check with their CPA or tax professional.